IFRS: Managing the Conversion
Sam Khoury
BDO Dunwoody LLP
Canadian Treasurer
May 2008
With publicly accountable enterprises required to convert from Canadian GAAP to International Financial Reporting Standards (IFRS) by January 2011, financial accountants in Canada’s public companies are rushing to meet requirements.
More private and even nonprofit enterprises are likely to follow. Given that it has been more than five years since companies in the European Union, Australia and South Africa started adopting IFRS, the benefits of conversion are now becoming apparent. Among those companies that have adopted IFRS, along with acquiring a common worldwide financial reporting language, financial reporting typically becomes clearer and simpler. As well, access to capital is often easier because of enhanced financial performance comparability. These represent vital competitive advantages in the global marketplace.
Organizations here in North America are learning from the experiences of IFRS-convert enterprises. Yet in Canada, much of the focus addresses the mechanics of IFRS conversion from a technical financial accounting perspective – calculators and the wording of note disclosures to meet the onerous requirements of the standards. For the most part, performance measures are still waiting at the sidelines.
The IFRS framework asserts that a company’s financial position on its reporting date is the main concern; the relevance of traditional performance metrics such as EBITDA and EPS are now questionable. This presents a significant gap between financial accounting and management accounting – whereas Canadian GAAP readily translates into performance measures, IFRS does not fit the mould.
The focus on financial position means that IFRS may impact profitability. Here’s an example: a company sells software with guaranteed future upgrades, the value of which is not yet determined. Canadian GAAP mandates that no revenue can be recorded until the software upgrades are designed, developed and delivered to the client or until the values of the upgrades are known and verifiable. Under IFRS, organizations could make an educated estimate of the cost and value of the upgrade based on historical or other evidence and could record revenues directly from the initial sale of this software while deferring an allocation for future upgrades. Canadian GAAP revenues would be lower than IFRS revenues in the initial accounting period and higher in the period when the upgrades were delivered. This causes an earning expectations challenge for management, shareholders and analysts.
While external stakeholders such as investors, lenders and shareholders are the key beneficiaries of the enhanced transparency and comparability of enterprises using IFRS, corporate leaders require consistent, reliable management accounting data for internal controls and decision making. Yet IFRS were not developed to serve as a standard for these purposes.
Thus management accounting systems must be adapted to support the financial accounting side of IFRS while also delivering best practices for the analytical data required for internal controls, performance management and strategic planning. This presents an opportunity to examine the metrics currently used within organizations and the methods used to derive them. Since conversion to IFRS requires major changes to information systems, management accounting requirements need to be integrated into this transformation process. This means management accountants should play a leading role in IFRS conversion planning and implementation to ensure the proper integration of control and performance metrics.
For any enterprise that competes in the global marketplace, a cost-benefit analysis will determine whether IFRS conversion would be a worthwhile investment. It’s important to consider whether other organizations in your industry sector intend to report under IFRS and, if so, whether the financial performance of your enterprise would benefit from comparisons. If so, then it would be worthwhile to take the next step and determine the organizational changes that would be required to adopt IFRS – how the new accounting data would impact each area of the organization.
In terms of management accounting, this might include performance measures, reports, processes, controls, compliance, technology, people, and the information systems supporting all of these. For example, the relevance of traditional performance metrics such as EBITDA and earnings per share is questionable under IFRS because the IFRS framework asserts that the balance sheet, which represents a company’s financial position as of the last reporting date, is the most important determinant of value. This results in significantly more volatility in the income statement. For instance, whereas certain costs may have qualified for capitalization, or deferral was mandated for certain revenue contracts, under IFRS these costs would not meet the definition of an asset and revenue recognition criteria would be met, thus they would all be recognized on the income statement. This could result in significant ebbs and flows of earnings from year to year.
Management accounting systems must be developed that support the financial accounting side of IFRS while also delivering best practices for the analytical data required for performance management and strategic planning. Thus those responsible for management accounting need to play an active role in the IFRS conversion process to ensure the effectiveness of data and measures.
Generally, an IFRS project may encompass four phases: impact assessment, planning, implementation and post-implementation review. Management accountants can participate in each phase, in tandem with the financial accounting side, in the following ways.
Impact assessment
- Identify key GAAP/IFRS differences in terms of management accounting.
- Conduct an impact and diagnostic analysis; this includes an analysis of anticipated changes to the measurement bases of relevant financial statement items, including current assets, current liabilities, revenue, cost of goods sold, etc.
- Define information requirements for management accounting purposes.
- Perform a cost/benefit analysis to compare the feasibility of performing lengthy reconciliations to obtain the requisite data versus adjusting the information system to automate portions of the process.
The most significant costs of IFRS conversion generally involve information technology, thus for the short term, some organizations may choose to amend existing systems rather than completely reconfigure the information technology infrastructure. It is, however, important to align conversion with an organization’s strategic business plans in order to minimize late-stage changes – and their potentially inflated costs.
The transition to consistent international financial reporting standards provides an opportunity to strengthen information processes and applications because IFRS requires that certain information must be reported in specified forms. Thus financial accounting and management accounting should perform this step in tandem to ensure complementary and efficient adjustments.
- Determine conversion strategy and timetable.
- Identify training requirements.
Planning
- Assess impact on performance measures and internal controls. Map these measurement changes to the metrics currently used to assess the performance of the organization. For example, determine if IFRS now permits cost deferrals and how this affects the assessment of profitability.
- Assess individual metrics to determine whether they will continue to deliver relevant or adequate information; for example, what impact will new revenue recognition policies have on performance metrics?
- Define changes required to management accounting policies.
- Develop a detailed conversion project plan including resource requirements, key milestones and deliverable due dates.
Implementation
- Map the conversion adjustments required; for example, determining what information the IT system would now be required to capture, such as credit risk by customer pool.
- Finalize management accounting policies.
- Provide staff training as needed.
- Post-implementation review
- Assess quality of analytical data delivered.
- Determine changes needed to meet best practice requirements.
- Finalize management accounting requirements for information systems.
For publicly accountable organizations in Canada, the sooner management accountants assume an active part in IFRS planning and implementation, the more effective internal control and performance data will be. And for accountants in private or nonprofit enterprises whose markets extend beyond Canada’s borders, this is the time to assess the potential of IFRS for these organizations.
Increasingly, management teams will need policies and practices that support daily decision-making within the IFRS concept of financial accounting and reporting based on the principle of fair value. As this concept continues to permeate markets around the globe, management accountants should be positioned to assume a leading role.
Sam Khoury, CA•IT, CPA, is a partner and Vaani Maharaj, CA, is manager, IFRS conversion services, of BDO Dunwoody LLP (www.bdo.ca). They assist clients in implementing initiatives related to International Financial Reporting Standards and business process enhancement. You can reach Sam at (416) 369-6030 or skhoury@bdo.ca.
